With the global economy facing a major downturn, the region’s economic resilience will be tested by weakening exports and a sharp slowdown of private capital flows, according to the December issue of Asia Economic Monitor (AEM).

“2009 is likely to be a difficult year for developing Asia but it will be manageable if countries respond decisively and collectively,” says Jong-Wha Lee, Head of ADB’s Office of Regional Economic Integration (OREI).

“Swift action by policymakers to stem both the threat to the financial systems and the real economy will allow most of the region’s economies to sustain a healthy if slower expansion.”

The AEM says that maintaining the growth momentum in domestic demand is key to keeping the regional economy in relatively good shape amid a weakening external environment.

Economic growth in emerging East Asia - defined as the 10 Association of South East Asia Nations (ASEAN) plus the People’s Republic of China (PRC); Hong Kong, China; Taipei, China; and the Republic of Korea - will slow to 5.7% in 2009 down from 6.9% percent in 2008.

The PRC, the region’s growth engine, is expected to moderate to 8.2% in 2009 from 9.5% in 2008 even as the government has undertaken measures to spur domestic demand to offset a slowdown in exports and private investment growth.

Further clouding the outlook is a deeper, more prolonged global recession creating persistent stress on the region’s financial systems.

“The risks to the region’s growth outlook are strongly tied to the global outlook through both trade and financial links,” says Dr. Lee. “Further financial disruptions could also exert a significant influence on consumer and investor confidence in the region.”

While the region’s economies and financial systems are fundamentally sound and appear better cushioned to withstand the immediate effects of the crisis than in other parts of the world, the report notes with concern that the global credit crunch is now spilling over into domestic banking systems, squeezing funding resources for corporate investment, and could boil over in some key regional economies if left unaddressed.

If banks in the region become more risk averse, the report warns, monetary policy may have less traction than in the past and governments will have to develop more active fiscal responses to shore up domestic demand.

The AEM urges the region’s policymakers to move swiftly to reduce the risk of a regional credit crunch.

It recommends policymakers step up their monitoring of local financial markets and have clear policies in place to deal with stressed institutions; provide adequate provisions of foreign and domestic liquidity so that credit continues to flow into the economy; and consider a range of policies to contain the spillover effects of the worsening financial conditions and risks arising from weaker growth on regional banking systems.

The AEM also recommends the region’s authorities continue to improve regulation and oversight of financial systems to (a) strengthen transparency and accountability; (b) enhance sound regulation and prudential oversight; (c) mitigate the procyclicality of financial markets; (d) broaden and deepen financial markets to enhance resilience; and (e) reinforce cross-border cooperation.

According to a special note, “Developing Asia’s Prospects in the Global Slowdown,” also released by the ADB today, South Asia is likely to reach 6.8% growth this year and 6.1% in 2009, down from 8.6% in 2007.

India, South Asia’s most dynamic economy in recent years, is reeling from the direct effect of the global financial crisis on its banking systems and financial markets, the special note says. The growth projection for India has been revised down to 7% in 2008 and 6.5% in 2009, down from 9% in 2007.